Fixed Income Viewpoints: Sticky Situations

The Viewpoints series gives investors Lazard’s perspectives on the latest macroeconomic and fixed income news and trends. In this edition, Lazard Asset Management's fixed income team share their assessment on the health of bond markets following more than a year of aggressive rate hikes. 

Inflation has been giving global bond markets the runaround.

Falling inflation in the United States finally gave the Federal Reserve a reason to not raise interest rates at its June meeting — welcome news for investors after 10 Fed hikes over 15 months. However, the inflation battle was not yet won: the Fed’s new rate forecast suggested two more increases before year-end, and inflation was “sticky” enough elsewhere to prompt a host of central banks to continue raising rates over the past few weeks.

The Bank of Canada surprised many investors by restarting its rate-hike cycle in early June after pausing for five months — and that followed closely on an unexpected rate increase from the Reserve Bank of Australia. Meanwhile, the Bank of England was expected to continue its hiking cycle later this month and possibly through the summer.

Of most concern to Lazard’s fixed income professionals when they met this month was the central bank tightening underway in Europe. Not only did the European Central Bank (ECB) increase rates in mid-June, but it was also about to take in some €500 billion in mandatory repayments on bank loans made during the COVID-19 pandemic through its Targeted Longer Term Refinancing Operations (TLTRO). At the same time, the ECB was winding down its quantitative easing program, and after June, no longer reinvesting the proceeds from its asset purchases.

This “significant drain of liquidity” from the financial system — at a time of year when liquidity is typically low to begin with — suggested to our experts that the bond markets, in particular the credit sector, were not out of the woods yet.

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